Friday, March 30, 2007

Speaking of small business creating jobs: Snohomish Co. office space is currently showing vacancy at about 18%. In Lynnwood, the office vacancy rate is approximately 25-30%. Industrial space (read: Boeing & suppliers) appears firm.

"The cause and effect of this is that tightening in King County tends to push people up I-5 to Snohomish County," Hoban said, though he said there are also a few new businesses sprouting up locally that have leased offices in Everett.

I suppose one could argue that just because there is a good chunk of office space available for small business (who typically drive the economy with job creation), that does not mean that hiring is slowing. Mixed signals?

Doing business in Edmonds recently, I noticed the sign-carrying-day-workers holding large signs on the corner of 205th & Hwy 99. "Comp USA Closing: everything 30-50% off." I also recently read that Circuit City is laying off staff. If consumer products are flying off shelves at these stores, why are these stores closing and laying off staff? What businesses will be taking over these large stores once they vacate?

Thursday, March 29, 2007

Fact: As of 2005, Seattle area per capita income is the 15th highest in the nation (source).

Fantasy: "That pretty much says it all." i.e. - Incomes in the Seattle area are so high, that it doesn't matter how slowly they are growing. High incomes alone will keep home prices from falling.

Reality: Of the six metro areas with higher per capita incomes than Seattle in 2005 that are included in the S&P/Case-Shiller Home Price Index, all six have experienced YOY home price declines in the past year (source). Three of the six have experienced a smaller total increase in home prices since 2000 than Seattle.

The table below shows Seattle and the six other metro areas with larger per capita incomes that are also covered by the S&P/Case-Shiller Home Price Index. "S&P HPI" values are normalized to 100 in January 2000, so the present value (January 2007) indicates how much home prices have risen since then.

Rank

Metro Area

S&P HPI

YOY Chg

2

San Francisco, CA

211.77

-1.4%

4

Washington, DC

238.05

-3.9%

5

Boston, MA

168.28

-5.6%

8

New York, NY

211.50

-0.9%

13

Denver, CO

135.86

-1.1%

14

Minneapolis-St. Paul, MN

167.98

-0.9%

15

Seattle, WA

183.92

+11.0%

Seattle definitely sticks out as an apparent winner, for now. Honestly, I don't know the reason that prices are continuing to rise here, but I do know some things that are not the reason, and "high incomes" is one of those things.

Wednesday, March 28, 2007

Let's play a game. It's called "Spot the Fundamentals," and the way we play it is by looking at some of the "fundamentals" to figure out which ones are responsible for our area's high home prices.

The frequent condescending argument of the cadre of Seattle area housing bulls (real estate agents, "analysts," the press, and increasingly combative blog commenters—whom I suggest we all ignore) is that unlike most of the rest of the nation, Seattle home prices are firmly supported by strong fundamentals such as exceptional job growth, high-paying jobs, and increasing population, and as such will not decline.

Let's play "Spot the Fundamentals" to see how well that claim holds up.

Well sure, if you call 3% growth in the last year "strong." Of course, while Seattle was one of the few parts of the nation where housing prices rose double-digits last year, there were 85 Metropolitan Statistical Areas that had better "job growth."

Unfortunately for the Bull Cadre, a 3% increase in jobs does not account for an 11% increase in home prices during the same time frame. As we have previously explored in detail, job growth (and reduction) in the Puget Sound has had little to no correlation with housing prices.

High-Paying JobsYeah, but even though the job market isn't growing by leaps and bounds, thanks Microsoft, salaries are shooting through the roof... right?

Not. If there actually were people moving here in droves, then yeah, that would explain home prices rising an average of 9.4% per year (King County SFH, 2000-2005). However, that clearly does not describe reality.

As I have demonstrated before, Seattle area rents (which are not subject to speculation) have indeed been tracking fairly well with "the fundamentals." Home prices clearly have not.

How anyone can (with a straight face) argue that "strong fundamentals" will prop up Seattle area housing prices, when they have so clearly been propelled by factors other than fundamentals, is completely beyond me. You can believe whatever you want to believe about where prices will go from here, but to say that they will be propped up by "strong fundamentals" is just willful ignorance, in my opinion.

If anyone believes they can explain how Seattle home prices have actually been tied to fundamentals since 2000, and wishes to civilly bring such an argument to the table, backed up by hard data (such as what is found in this post), then by all means be my guest. However, don't waste your time with one-liners, "bitter renter" put-downs, and simplistic observations of inventory and ongoing price increases, as they will be ignored.

Tuesday, March 27, 2007

Home prices go negative for first time in 11 yearsCase-Shiller price index shows prices falling in 17 of 20 cities in January

WASHINGTON (MarketWatch) — U.S. home prices continued to fall in January, with prices in 10 major cities now down 0.7% year-over-year, according to Standard & Poor's and MacroMarkets LLC, which released the January Case-Shiller price indexes on Tuesday.

The 10-city index is down 0.7% in the past year, the first year-over-year negative reading since 1996. The 20-city index is down 0.2% year-over-year. A year ago, prices were rising 15%.

"The annual declines in the composites are a good indicator of the dire state of the U.S. residential real estate market," said Robert J. Shiller, chief economist at MacroMarkets, in a statement.

Of course, since you already know how special Seattle is, you obviously know it was one of the three cities in which prices are not presently falling. But the picture isn't quite as rosy as you might think...

Home prices fell from December to January in 17 of the 20 cities; only Miami showed any price gains. Prices were flat in Charlotte, N.C., and Seattle. Prices were falling fastest in January in San Diego, down 1.7%, or a 22.4% annual rate. Prices dropped 1.1% in Los Angeles, or a 14% annual rate.

The 10-city index was down 0.8% in January, or an annual rate of 10%. The 20-city index was down 0.7% in January, or an 8.7% annual rate.

Eleven of the 20 cities had negative price appreciation in the past year, led by Detroit (down 6.9%) and Boston (down 5.6%). The biggest increases were in Seattle (up 11.1%) and Portland, Ore. (up 8.7%).

Prices have now retreated year-over-year in some of the regions that had the biggest price gains in 2004 and 2005. Phoenix is down 0.7% year-over-year. San Francisco is down 1.4%. Washington is down 3.9%.

I am reminded of an image that was circulating a while back. It was a photograph of a roller coaster just as the cars crested the peak and began the ride down. The various cars were labeled as different cities around the country, with San Diego in front (beginning to head down quickly), Phoenix in the middle (just starting a downward trend), and Seattle in the back (just "leveling off").

To me, it only makes sense that the cities that began the ridiculous run-up first (San Diego, Phoenix, etc.) will be the first to head down. Conversely, cities that were late to the wild appreciation party (Seattle, Portland, etc.) will be the last to experience price declines. But why bother with "logic" and "reason" when you can put your blind faith in the mystic power of "job growth" and undefined "fundamentals." 11.1% forever!

Monday, March 26, 2007

Hundreds of new, pricey condominiums exclude young singles needed for a thriving city core, according to the author of a study analyzing the downtown housing market.

Builders and developers say land costs and water views push prices beyond the mid-$200,000 range generally considered doable for the first-time buyer. And even though the number of unsold units remains high in some neighborhoods, they say demand is strong for high-end condos. Tacoma’s average new condominium price, according to the study, was $348,893 at the end of last year.

The 149-page report, finished last week, identified three kinds of future condo buyers: female baby boomers, young professionals, and married folks with no children at home. It recommended adding edgy lofts and more small spaces that Generation Y buyers can afford....As of December, all six neighborhoods surveyed averaged 14 months of condominium inventory, which measures how long it would take to sell everything built and approved.

A healthy market for new construction tends to be in the six- to 12-month range, said Deanna Sihon, the study’s author....Since 2004, nearly 400 condos have been sold downtown with another 525 for sale and about 1,500 proposed, according to the study....A year ago, a hot market meant condo shoppers had to make rapid buying decisions, said RE/MAX real estate agent George Pilant.

Not so now.

“Buyers have so many choices they don’t feel a sense of urgency,” he said....As in any type of residential real estate, demand is driven by population and job growth, said Paul Turek, an economist with the state Employment Security Department.

But condos are a niche product that at higher inventory levels, he said, raise this question: Will good-paying jobs needed to sell such downtown housing continue to be created?

“I suppose that’s where the gamble is,” he said. “In the Tacoma area, we have some high-paying jobs. Whether there’s enough to support the building of the condos remains to be seen.”

Nearly 800 new downtown condos and apartments are in various stages of planning.

There's a good chance some of the projects scattered across a dozen development sites will not get off the ground, officials acknowledge.

Still, long-term growth, a property tax subsidy and a strong local economy, buoyed by jet sales at the Boeing Co.'s Everett factory, work in the city's favor.

...

The condo market in the Puget Sound area remains hot, in spite of a wave of foreclosures and slumping housing sales creating jitters and sliding prices elsewhere.

Developers in Everett talk about "pent-up demand" and say they aren't deeply concerned their projects will create a glut of vacant condos for sale, as is the case in Las Vegas and parts of Florida.

"I think the local market is way stronger than people realize," said Joe Zlab, who plans to break ground on Rockefeller Square, a 40-unit condo building on Rockefeller Avenue, north of Everett Avenue, this spring.

...

It's only a matter of time before Everett begins to resemble more affluent Seattle suburbs, including Bellevue or Kirkland, said Anthony Aversano, a Mountlake Terrace remodeling contractor.

"Seattle is overpriced, Bellevue has access problems and is also too expensive," Aversano said. "It's not a place where people can go unless you're working for Microsoft and have been there for a long time."

Gus Boutsinis, a Mill Creek developer working on a 130-unit condo project on 41st Street and Colby Avenue, agrees.

"We think Everett is ready," he said. "It's where Seattle was 15 or 20 years ago.

Friday, March 23, 2007

I'm compiling two lists for future posts, and I'd like to enlist the help you, the intelligent readers, to help assure the lists are as complete as possible. The purpose of the posts will be to list common real estate myths and briefly debunk them one by one. Many common myths have had entire posts dedicated to them here in the past, which will of course also be linked to. Following are some examples of the kinds of things I'll be including on these lists.

The first list is "Seattle Housing Market Myths," which will contain items such as:

Home prices in Seattle are supported by:

Job growth

Population growth

Puget Sound's unique desirability

Prices here did not go up as fast as other places, so therefore they won't fall.

Prices can simply level off for a few years while "the fundamentals" catch back up.

etc.

The second list is "General Home Buying Myths." Here's a sample of what I've got so far for that one:

Thursday, March 22, 2007

One of the frequently-repeated arguments that real estate salesmen use to try to convince the renter-serfs to buy a home is that once you buy a home, your costs are fixed. While that's not entirely true (taxes, insurance, and maintenance can all increase—and it's not true at all unless you get a fixed-rate mortgage), the costs can certainly be more stable than renting, where your monthly rent is likely to increase with inflation.

However, the very same people that tout the "fixed-cost" of home ownership will turn around and offer another argument for buying: get on the equity escalator so after your home appreciates you can trade up to nicer digs. This is where I get confused. If your goal is to "trade up" for a nicer home in 5-10 years, aren't you negating the entire "fixed costs" argument?

Let me throw a few numbers out here to try to explain what I'm talking about. Let's say Milton S. and his wife are paying $1,200 per month to rent a little two-bedroom house. They decides to stop "throwing away their money" on rent, and rush out to purchase a home (before they get priced out forever), finding a two-bedroom 1,200 sqft house in Shoreline for $325,000. Assuming they get a 30-year fixed at 5.75% and have the $65,000 to make a 20% down payment (a fairly generous assumption), their monthly PITI payment is now just shy of $1,900. They do save over $2,000 that year on their taxes, so let's shave off a slightly generous $200 per month, and round the monthly payment down to $1,700.

Right off the bat our example couple has willingly signed up for a 42% hike in their monthly expenses (not counting maintenance). That's quite a premium to pay just so you can have "fixed costs." With hikes of 3% per year, it would have taken 12 years for their rent to reach that level. But hey, at least their costs are fixed, right?

Well, what happens when 10 years down the road they want to "trade up"? Thanks to the "equity escalator" and annual 4% appreciation, their $325,000 house nets them a sweet payday of $227,500 (after fees & taxes). Unfortunately, the house they would like to trade up to—a four-bedroom, 1,900 sqft house in Ballard that cost $450,000 when they bought their first home—has been appreciating at 4% per year too, and now costs $666,110. Even after putting the entire amount down from the sale of their first home, their monthly PITI payment (minus tax savings) will jump 65% to $2,800. The situation is even more skewed if you assume greater appreciation (like say, 7%), with their $1,700 payment skyrocketing to $3,294.

After 10 years and just one trade up, jumping on the equity escalator has resulted in a 133% increase in monthly costs for our fictional couple (over the original $1,200 rent). If they had instead continued renting, their monthly rent after ten years would have increased "just" 34% to $1,613.

So I guess what I'm saying is that I can't see how the "fixed costs" and the "trading up" arguments can both be true. The real issue here seems to be that the idea of trading up when an over-inflated market is your starting point just doesn't make any sense. If Milton and spouse had bought that $450,000 home to begin with, still only putting down $65,000, the monthly PITI would have only been $2,521 (assuming PMI— it would drop to $2,350 in three years when the equity reached 20%).

Can anyone describe to me a situation in which "trading up" is a winning proposition?

Wednesday, March 21, 2007

I just got off the phone with the producer of the Brian Suits show over at KVI (570AM). Brian will be discussing yesterday's P-I article, and thanks to a heads-up from Eleua, I'll be a guest for a part of the discussion. Tune in at 3:00. They have a web feed for those of you still at work.

Update: I was on the air for roughly the first five minutes of the program. The discussion was primarily driven by Brian's questions, so I wasn't able to work in as many points as I would have liked, and I certainly could have said "uh, um, er..." a bit less, but this site definitely got some decent free advertising.

Only three callers were able to get in a word before the topic transitioned to something else. Here are a few highlights:

John in West Seattle:

I conduct six or seven real estate purchases a week and I see the problem with your guest, the facts of the Seattle market do not fit his theory. ... Real estate values are subjective, they're based upon what people want for their own reasons. There is no objective value that can be placed at any given location or time. ... Housing prices go up because that's what people are willing to pay. ... People are speculating when they buy real estate, they hope it will appreciate in value over the years, but in a strict sense of speculation, that would apply to investment properties.

He sounded fairly angry, and he also called the Global Insight study "hogwash." If I had been able to respond to "I conduct six or seven purchases per week" John (i.e., a real estate agent), I would have pointed out that he is correct, real estate values are subjective. However, home prices have very suddenly spiked up at a historically unprecedented pace in the last five (or so) years.

Has Seattle suddenly become far more subjectively desirable during that time? No. I have covered this nonsense argument in a number of posts, most notably A Question Of Affordability, last November.

Gary on a cell phone:

The "hogwash" comment is absolutely dead on. It's just a function of the market. People pay what they're willing to pay, and people sell what they can sell for. A couple factors that make our market higher than a lot of other areas are at least two things: One is a lack of transportation infrastructure, and the other thing is the Growth Management Act

The transportation argument would perhaps partly explain why Seattle proper is so expensive, but unfortunately for Gary's argument, pretty much the entirety of King, Pierce, and Snohomish counties have seen similar spikes in home prices over the last five years. As far as his Growth Management claim, I've covered that here and here.

Scott on a cell phone

I've been in the lending side for the last ten years. ... Seattle is over-inflated. If you talk to any banker, lending institution, they will tell you, their biggest worries are the big metropolitan areas: San Francisco, Seattle, Los Angeles... where you've had such growth in the appraised value. ... There are a lot of realtors out there who are over inflating the value of these homes. ... The bubble may not burst, but there will be a serious deflation in the next few years, and it's gonna be based on the fact that the lenders have had enough.

Scott's points were pretty much right on. He sounded like somebody that has a pretty good grasp of what's going on before our very eyes with the interplay between home prices and lending.

I have audio of the segments of the show with the callers. If you're interested in hearing it shoot me an email. Hopefully I'll have another chance in the future to get the word out.

Buy If You Must. Why Must You Buy?

I need to take a step back and insert a personal note. While I disagree with the motives and actions of the faceless Real Estate Industrial Complex (REIC), there are genuine, honest, intelligent and wonderful people that work as RE agents, mortgage planners, title agents, contractors, appraisers, granite counter fabs, etc. It might be difficult to find one of these in an sub-prime boiler-room, or on a CNBC interview, but there are those out there making a living that are just as much of a victim as their customers. Please separate my disdain for the high priests and the overall entity from the honest people that believe they are trying to help someone achieve a dream. Second, difference of opinion does not constitute condemnation. I enjoy a healthy, spirited, raucous discussion more than most. At the end of the day, drinks are on me.

With that said, let's get on with the flogging.

I will be the first to say that buying is a good idea if you intend to live in the house for the bulk of the mortgage period, you can afford it, and it is viewed as your nest, rather than your nest egg. If you are a transient, or you are trying to save for retirement by living in your 401(k), you might get lucky and you might get ruined. Houses are homes. They should not be investments.

200-7! You Crapped Out.For the past several years, we have been living in a speculative economy. During the late '90s, this was manifested in stocks, and now it is takes the form of residential real estate. Everyone wants in on the fun. Why not? Real estate, like stocks, always goes up in value. It is a great investment, and the way for normal people to build wealth. At least that is what the Real Estate Industrial Complex (REIC) wants you to believe. They don't make as much money if you are skeptical.

At first glance, it sure seems like a dynamite investment. Everyone has a grandmother that bought her $600,000 home back when it was $60,000, and if you live in California or Seattle, you can't go 15 minutes without running into someone yammering on about how much their home has gone up in value. Some idiots treat a daily visit to Zillow like they would a call from their stockbroker.

By Your Lease, My LandlordThe new homeowners are buying into the idea that America does, in fact, have a class system: the Landed Class, and the Perpetual Renters. The Landed Class have unlocked the secret to passive wealth, and the Perpetual Renters are condemned to the outer darkness of blowing their savings on their landlord's mortgage - a double insult.

All current living generations in America have been force-fed the idea that home ownership is absolutely essential to financial freedom. It is an article of faith in the national religion. Question this and you are branded a heretic. Somehow, through an Orwellian twisting of the language and a corruption of the educational system, debt became wealth. The last two generations that would have disputed this have passed on.

Morons + Money = LumpeninvestoriatThe REIC sells homes as investments to the Lumpeninvestoriat. Homes are more expensive if the parties attach a high speculative premium. The higher the speculative premium that accompanies a property, the higher the price will be. This reinforces the validity of the speculation. Normally, this is called a bubble. The REIC makes a lot of money fomenting a bubble.

Is a home a good investment? If by investment you mean that it throws off the dividend of a place to call home, then yes. Renting provides the same benefit. If you are seeking a "forced savings program" and capital appreciation, you might be better off with payroll deduction and a quality, value oriented, contrarian investment portfolio.

Pay No Attention To The Details Behind The CurtainLet's examine a common exercise that many in the REIC like to conduct to shore up their position that your home is your nest egg.

Owning a home is not right for everyone. There are certain benefits to not owning the home you live in. If something goes wrong with the property, you simply ring up the landlord and they get to fix it. You pretty much know what your cost are going to be month to month (unless your landlord decides to sell the property, increase rent, convert the condo, etc.). On comments from last Friday’s post on interest rates, there is a discussion debating if one could consider having a mortgage as a forced savings plan. I know I'm going to seem biased since I am a Mortgage Planner…and I fully expect all of the number-crunching-junkies out there to have a heyday with what I'm about to post…but here goes!

I found two similar homes, both in the north Seattle area. The rental property is available for $1850 per month. The home for sale, with close square footage, rooms, area, etc., is available (actually, an offer is pending) for $499,995.

With the comparison, I'm going to assume someone has 20% down to either invest in the stock market or to buy a home. The current rate for a 30 year fixed is 5.75% (APR 5.904%). Principal and interest is $2,334 plus taxes and insurance equals a total payment of $2623. First year monthly tax benefits are $606 (mortgage interest benefit will decrease, property tax benefit will most likely increase).

The prospects are in the 28% tax bracket; they have a gross income of roughly $8000 per month and can have $700 in monthly debts with credit scores at 680 or better. The investor will receive 11% from the stock market and the homeowner will benefit from an appreciation of 7% on their real estate.

Rent

at 5 years

Homeownership

at 5 years

Total Payment

$117,863

Total PITI

$157,396

Principal Paid

0

Principal Paid

$28,951

Tax Benefit

0

Tax Benefit

$35,293

Net Cost

$117,863

Net Cost

$93,152

Real Estate Value

0

Real Estate Value

$701,269

Loan Balance

0

Loan Balance

$371,045

Total Home Equity

0

Total Home Equity

$330,224

Rent

at 10 years

Homeownership

at 10 years

Total Payment

$254,498

Total PITI

$314,792

Principal Paid

0

Principal Paid

$67,519

Tax Benefit

0

Tax Benefit

$67,893

Net Cost:

$254,498

Net Cost:

$179,381

Real Estate Value

0

Real Estate Value

$938,566

Loan Balance

0

Loan Balance

$332,477

Total Home Equity

0

Total Home Equity

$651,089

Investment

Investment

Opening Balance

$109,000

Opening Balance

0

5 Yr Return @ 11%

$188,452

5 Yr Return @11%

0

10 Yr Return @11%

$325,817

10 Yr Return@11%

0

5 Year Net Worth

$188,452

5 Year Net Worth

$330,224

10 Year Net Worth

$325,817

10 Year Net Worth

$651,089

The first five years with the mortgage provide an average monthly principle reduction of $482.47 per month. Taking out any appreciation factors, the principle principal paid each month is a forced savings plan. With that said, home equity does not earn interest. And I would probably encourage most clients to consider not using the entire 20% for the down payment to stay more liquid (depending on their entire financial picture).

For many Americans who do not have a savings plan (and the statistics show that many do not save), owning a home is as good as it gets for building savings…and it ain't so bad.

Let the games begin!

This is a very common proof put out by the REIC to keep the Lumps feeding from their trough. I've seen it in a dozen different forms. If it was posted on a billboard, and you drove past it at 70 mph, on a crowded freeway, it would make sense. Fortunately for the REIC, the flashbulb attention span, in combination with the economic and historical illiteracy of your average homebuyer makes this work.

Is This Apples-to-Apples, or Salmon to Mullet?Using the provided example as the basis for comparison, we will take out our pencils, calculator, green eyeshade, and a case of Mountain Dew and hammer out a valid side-by-side look at renting vs. owning.

Rent is $1,850/mo. I guess if you show up looking like you just crawled out from a flophouse in Pioneer Square, you would pay full price. In this market, if you showed any semblance of responsibility and wanted to negotiate, you could knock 15% off that price. However, we will go with the $1,850 to keep as close as we can to "apples to apples."

Our poor, pathetic loser renter is on the hook for $1,850/mo + 3% hikes per year. Over the first 5 years he lays $117,863 on the altar of his landlord's good fortune. In 10 years it amounts to $254,498. This assumes that rent tracks at 3%, which with all the building and speculating in real estate is a pretty bold assumption.

Over the same time our budding noble is also shelling out money for his living situation. He paid $100,000 for the down payment, and (according to Rhonda) currently pays out $2,623/mo in principle / interest / taxes / insurance (PITI).

Up until now, I am in agreement with Rhonda. We now need to look deeper into the realities of home ownership to find the true value of each living situation.

Real Estate Always Goes Up - It's In The ConstitutionPerhaps the biggest flaw in the classic "Rent vs. Own" comparison, as put out by the REIC, comes in the form of assumed appreciation of the underlying asset. It is given as an absolute certainty that real estate always goes up. Yes, in the past few years that has been the case. Will it happen tomorrow? Nobody knows - nobody. To assume this is, at best, irresponsible. Capital appreciation is never assumed when assigning value to an investment. Capital appreciation may be estimated for speculative purposes, but not investment purposes.

I am not against speculation - I do it all the time. However, it is speculation; it not investing, just as meaningless sex is not love. There is a huge difference. It is very important not to have expectations of one when engaging in the other. Assigning a value based upon the dividend or benefit an asset provides is investing. Assigning a value based upon someone else's view of the price is speculation.

It's Clear Sailing In The Rear-View MirrorI wonder how anyone in the REIC can so confidently forecast an appreciating market? How do we know the market will not shift into reverse? We don't. Yes, we can guess, but we don't know. I would submit that after the breathtaking run in real estate over the past few years, and the problems that we are facing in the mortgage finance space, a very strong argument can be made for a precipitous drop in real estate prices - even in Seattle.

If you run the appreciation at +7%, you would be well served to run it in reverse to give a range of expectations. Back in 2000, many stock bulls (especially those on Wall Street that profit from high priced stocks) believed in the "New Economy." This New Economy was based upon the absolute fact that certain, high quality stocks will always go up in price. Microsoft, Yahoo, Intel, Cisco, Juniper, Qualcomm, eBay, Lucent, Corning, etc. were all touted as fail safes. Seven years later, these predictions look foolish and self-serving. Had speculators prepared for a significant rollback, the pain may have been alleviated to some degree. Going "all-in" at the wrong time is devastating.

Removing the miracle of perpetual appreciation, the 5 and 10-year numbers for owning would have to be reduced by $201K and $438K respectively. If we reduce the appreciation by the same amount as we assume it appreciates, the owner's position is reduced further by $126K at 5 years, and $240K by 10.

This is a pretty wide differential for something we don't know. A prudent analysis would be to not factor in any appreciation. Such was the example in Northern California from the late '80s to the late '90s.

Show Me The Money! - Well…Let's Hold Off On That.In addition to the folly of just assuming that an asset will appreciate, it is incumbent upon the buyer to understand why an asset appreciates. Home prices track incomes as well as the ability to find easy money. Without easy money, homes could not appreciate beyond what incomes could support. A house is not a bank account that accrues compounding interest.

Unfortunately for our prospective homebuyer, both sources of rising home prices are under attack. Mortgage lending has been a festival of economic irresponsibility since 2003. Up until early 2007, anyone could qualify for just about any amount of money with absolutely no documentation or lender vetting. The finance industry made billions selling high fee mortgages and chopping them up for sale in the secondary markets. It was a fundamental blunder to build a business model (or an entire industry for that matter) on lending money to questionable borrowers with lousy collateral. That business is now disintegrating right before our eyes. Lending standards will be increasing dramatically (driven by both government and investors), and rates will certainly rise. The go-go days of insane lending are in the rear-view mirror.

Global wage arbitrage with Mexico, India, China, Russia, and Brazil are keeping a tight lid on incomes. Incomes have been stagnant over the entire duration of the housing bubble, and show no sign of any broad-based increase. Other considerations include rising taxes to pay for the increasing scope of government, immigration pressures, and the retirement of 77 million Mouseketeers.

Comparing With Four Hands Tied Behind Your BackWhile Rhonda was generous with her assumptions of the ROI of the renter's investment portfolio, I wonder why this investment wasn't treated in the same manner as the appreciation on the house? Why can't the investment portfolio also include 4:1 leverage? Why assume 11%? If we are in the business of forecasting good things by looking in the rear view mirror, why not use a real example from another investment that took place over the same time period as the latest housing bubble? A 4:1 leveraged investment on silver bullion would have returned $1,120,000 on a one-time buy-in of $100,000 over the past 7 years.

Tax Benefits Need A Tummy TuckThe tax benefit is overstated. Yes, itemizing mortgage interest and property taxes is a great benefit. If you make $96K/yr, you can do quite well come tax time. The problem comes with the "standard deduction," which is the tax deduction that you get without itemizing. The standard deduction is less for a single man, than it is for a family. Rhonda assigns $35,293 of tax benefit for 5 years and $67,893 for 10. If we correct for the standard deduction for a family, that tax benefit is reduced to $20,873 and $39,053.

Oops, Your PITI is SlippingThe PITI was probably too low. $288/mo for taxes and insurance is probably more like $550. Tax rates are considerably above ½%.

It is doubtful that the county would keep property taxes stable. Even in a period of decreasing values, it is very easy for local governments to keep their bloated budgets going on the backs of the local citizenry. Even if you assume the tax rate holds steady, if your property is increasing in value, so is your property's government-assessed value, right? 5 to 10 % property tax increases are certainly well within normal assessments. Let's say the assessment increases at the same rate as the assumed appreciation, but with a 5-year lag.

So, What Are You Doing This Saturday?Houses are also maintenance intensive. Rhonda assumed that our homeowner never needed to repair his castle, nor make a visit to Home Depot. If the homeowner spends 1% of the value of his home on maintenance and improvements (what's a trendy Seattle home without granite, stainless, and bamboo?), we need to add another $400/mo to the equation.

The Highest Fee BrokerageFinally, the REIC never likes to bring up that a hefty fee exists for cashing out of the home ownership money machine. You need to pay them a minimum of 7% of the gross sale to get at all that wonderful equity. Assuming the home price remained constant, that is another $35,000 out of the piggy bank.

The Bottom LineNow that we have a more complete picture of the situation, let's take a look at the financial bottom line for rent vs. purchase in few possible scenarios. We'll use Rhonda's given purchase price, down payment, investment return (11%), and rental price, varying only the assumed appreciation in each case. "Home Value" refers to the total amount of money you pocket upon the sale of the house (since that is the only way you can get the money).

7%

Rent

Purchase

Appreciation

Investment Value

Home Value

Difference

Advantage

@ 5 years:

$224,343

$275,668

18.6%

Purchasing

@ 10 years:

$402,613

$574,573

29.9%

Purchasing

@ 25 years:

$1,662,659

$1,815,340

20.3%

Purchasing

4%

Rent

Purchase

Appreciation

Investment Value

Home Value

Difference

Advantage

@ 5 years:

$224,343

$189,950

18.1%

Renting

@ 10 years:

$399,918

$350,060

14.2%

Renting

@ 25 years:

$1,565,654

$1,030,024

52.0%

Renting

0%

Rent

Purchase

Appreciation

Investment Value

Home Value

Difference

Advantage

@ 5 years:

$224,343

$90,051

149.1%

Renting

@ 10 years:

$396,625

$128,619

208.4%

Renting

@ 25 years:

$2,172,580

$461,100

371.2%

Renting

-2%

Rent

Purchase

Appreciation

Investment Value

Home Value

Difference

Advantage

@ 5 years:

$227,271

$45,749

396.8%

Renting

@ 10 years:

$399,452

$44,272

802.3%

Renting

@ 25 years:

$1,454,580

$156,786

827.7%

Renting

The Million-Dollar Taffy PullSo, did we answer the question of it being better to rent versus own? Not really. It is all based upon how congruent your assumptions about the future are with the reality. Nobody knows what will happen next week, much less 10 years from now. I would say that wildly optimistic assumptions of owning compared to a watered down forecast of the economic flexibilities of renting is not a valid comparison.

People always forget that using borrowed money for investing (whether it is a brokerage margin account or a mortgage) is leverage. Leverage works both ways. It amplifies your success or failures. What turns 4 walls and a roof into the American Dream is the same mechanism that makes it your financial coffin.

Yes, if you get enough appreciation of a home's value, it makes sense to buy. This is true on any investment. However, if the home stagnates in value, or falls, the damage is magnified by the mortgage, taxes, and illiquidity.

Home ownership brings certain benefits like some level of sovereignty over the use of the property and any ephemeral value from "pride of ownership." It also brings other pitfalls, such as illiquidity, maintenance, acts-of-God, or even your overweight, aging hippie neighbors that insist on walking around naked as they oscillate between the hot tub and the "herb" garden.

Renters may need more than just the consultation of a sledgehammer and a case of Mickey's Big Mouth to knock out a wall, but if a heavy-metal band moves into the house next door, they can give notice, pull up stakes and move into a nicer home. If a renter gets transferred, they don't have to put up with the agonizing process of selling a home in a squishy market, and then paying 7%+ to the REIC. At worst, they lose their deposit and move on.

Lending While IntoxicatedAs the mortgage finance industry scraped the bottom of the barrel to find new suckers buyers to put into homes, they swerved head-on into the world of the financially illiterate. Many of these buyers did not have sufficient savings to pay the standard first/last/deposit as required for most rental contracts. Many did not have sufficient income to qualify to rent, yet the finance industry was able to qualify them for a home. This was done under the pretense of getting them into a beneficial financial situation. Rhonda summed it up as follows:

"For many Americans who do not have a savings plan (and the statistics show that many do not save), owning a home is as good as it gets for building savings…and it ain't so bad."

Yes, I guess you can refer to the principal paydown on a house as a "forced savings plan." It is true that most Americans do not have any form of savings, other than their aging Beanie Baby collections, so I guess this is better than nothing. It also presupposes that most Americans are idiots. With that, I agree, but would like to add that allowing an idiot to juggle a half-million dollar, highly leveraged, speculative savings plan is a recipe for an unmitigated disaster in their personal life. Set this against the backdrop of tens of millions of the very same, and you have the certainty of a national financial disembowelment.

Given the recent activity in the sub-prime mortgage finance companies, this hypothetical is now a reality.

Tuesday, March 20, 2007

By now most of you have probably already seen today's article in the P-I: Homes overvalued by 31.7% in city, report finds. It's pretty much the usual shtick. "Homes are expensive here, but..." followed by lots of quotes from various real estate "analysts" and "professionals" yammering on about how wonderful the "fundamentals" here are, what with all the high tech job growth, etc., etc..

Here are a few obligatory quotes:

The typical house in the Seattle metropolitan area was 31.7 percent overvalued in the last quarter of the year, up 6.4 percent from the prior quarter and 24.3 percent from the end of 2005, according to Monday's joint report from Global Insight......"You're sort of on the edge," [Global Insight talking head Jim]Diffley said. "We would say you're not in the riskiest group of metro areas."

Seattle's strong economy and the fact that its prices started their recent climb later than many areas further diminish the risk, he said. "We're not forecasting a 31 percent decline by any means."

Local experts question the idea that Seattle houses are overvalued at all.

"Sure, prices have gone up, and they've gone up rapidly," said Glenn Crellin, director of the Washington Center for Real Estate Research at Washington State University. "But we're still in a situation where the market fundamentals are extraordinarily strong."

Matthew Gardner, a local land-use economist, said Seattle did not see the 100 percent to 150 percent appreciation or the overbuilding that occurred in places such as Southern California.

"We've got high incomes, we've got a job growth rate twice the rate of the country as a whole, we've got growth management," he said. "Will we see a slowdown in appreciation? Absolutely, and that's appropriate."

Randy Bannecker, a consultant housing specialist for the Seattle-King County Association of Realtors, said there just are not enough homes available to cause overvaluing.

"The overwhelming supply shortage is really what's keeping the prices where they are," he said. "It's hard to see where just kind of a run-up for run-up's sake is in play."

Its no longer a matter of "Californians willing to pay premium prices for our houses"....now its a matter of a vibrant high tech economy that has created massive amounts of wealth, drawn talented individuals and families from around the world whose high paying tech jobs allow them to afford high priced houses.

In reality, Microsoft and other employers have made Seattle much more of a meritocracy -- where the talented earn much more than those unskilled in high-demand technical knowledge. These higher paid folks see the value in Seattle housing, and are willing to pay high prices for this ideal location.

So, instead of blaming Californians, blame highly skilled microsofties for pulling Seattle out of its historic "boeing dependent manufacturing economy" with its boom and bust cycles.

How delightful for us to have an economy that has evolved so vibrantly.

Getting back to the article itself, I find it interesting that the 31.7% figure is said to be "up 6.4 percent from the prior quarter," when the last report I saw out of Global Insight had Seattle at 33.8% overvalued. Anyone know what's going on there?

Anyway, make of this report what you will. Personally, I don't need some "global leader in economic and financial analysis" to tell me that homes prices in Seattle are seriously out of whack. It seem pretty much self-evident to anyone willing to do half an hour of research.

Monday, March 19, 2007

When the question is "how will the current home lending meltdown affect the housing market in Seattle," the answer depends on who you ask. For instance, if you ask #1 Seattle real estate cheerleader Elizabeth Rhodes, the answer is something to the effect of: "Seattle is special. Don't worry your pretty little head about it."

Q: Local real-estate experts keep saying Seattle's housing market will stay strong because the local economy is strong. But I think all the subprime loans going bad will mean a lot more houses on the market and prices here will sink. Why don't you report that?

A: Let's start with an interesting fact from Douglas Duncan, chief economist for the Mortgage Bankers Association: More than one-third of all homeowners have paid off their mortgages (or paid cash). This significantly decreases the potential for overall risk.

However, the growing crisis in the subprime mortgage industry, fueled by an increasing number of mortgage defaults, is real.

How much of an effect it may have is very location-sensitive, said Bob Visini, a spokesman for LoanPerformance, a California company that tracks nationwide mortgage activity.

The Seattle/Bellevue/Everett area "is exposed," but way down the list, Visini said.

The Seattle area is in the bottom 20 percent for subprime mortgages among 331 major metropolitan areas — far below other parts of the country, particularly parts of Texas and California's Central Valley where subprime accounts for nearly a fifth or more of all mortgages. At the top of the list was McAllen, Texas, where some 26 percent of loans are subprime.

By comparison, only 7.9 percent of all Seattle-area mortgages were subprime at the end of 2006 (ranking 278th out of 331), down from 8.7 percent the previous year.

And only a fraction of those loans were in trouble — some 7.6 percent at the end of 2006 were 60 days late or more, a sign foreclosure is looming. This put Seattle in the bottom 10 percent.

Those are certainly some convincing statistics Ms. Rhodes has pulled out. Unfortunately, she still employs her mad misdirection skillz in composing the answer. The reader didn't ask "how does Seattle's rate of subprime mortgages compare to other cities?" Nor did they say "the subprime lending implosion is already affecting Seattle." Rather, they pointed out the high likelihood that the subprime mess will adversely affect Seattle's housing market. Granted, it may not affect Seattle as much as other areas with higher percentages of subprime loans, but there is no reason to believe that it will not have any affect.

On the other side of the media spectrum, ask Mike Benbow of the Everett Herald the same question, and he might say: "Foreclosures are already on the rise, and will likely increase. If the country heads into a recession, the housing market will almost certainly suffer even more."

Others are using risky loans, such as those where they're paying only interest for a while, to get into homes they can't afford. That can only lead to trouble.

In fact, it already has.

A recent article in the Puget Sound Business Journal quoted RealtyTrac Inc. as saying there were 2,377 foreclosures on homes in Snohomish County last year, a 35 percent increase over 2005.

That was lower than King County, where foreclosures rose 41 percent, and Pierce County, which showed a 58 percent hike. But it was higher that the 25 percent increase for the state as a whole.

Such a sharp increase in foreclosures tells us there are problems in the industry.

A local or national recession could trigger even more.

What am I trying to say here?

I guess that a rising local economy has kept the housing market relatively strong locally, but that things could change rapidly if economic circumstances change. Now, more than ever, home buyers should be careful about the types of loans they're using and not expect home appreciation to bail them out of a purchase they never should have made.

Wow, it's refreshing to read something that honest in the media once in a while. Foreclosures up 41 percent in King County? Funny, I must have missed the article in the Times where Ms. Rhodes covered that. I thought our housing market was the picture of perfect health. How could foreclosures be rising so quickly? Hmm.

Saturday, March 17, 2007

A few days ago, Rhonda over at RCG made a post titled The Great Rent vs. Own Debate in which she attempted to prove that even in today's totally out-of-whack housing market, purchasing a home is still a better financial decision than renting. Obviously I disagree with her assessment.

The main problem I have with Rhonda's post is the overly simplistic nature of the comparison. Chief among her oversights were the omission of maintenance cost of the purchased property, overestimation of the purchaser's tax benefits, and not adding the renter's monthly savings to their investment.

In order to properly respond to her post, I have begun to put together a spreadsheet that will compare the financial situations of renting vs. purchasing (I won't say "owning" since you don't actually own it until you've paid off the mortgage). However, before I get my Excel on in a post of its own, I want to get some feedback about what factors should go into the calculation. Here's what I've got so far:

Renting

Costs

rent

insurance

utilities

Savings

cost difference

Returns

investment interest

Purchasing

Costs

interest

insurance

utilities

taxes

maintenance

HOA Dues

Savings

principal payment

tax deduction

Returns

appreciation

My spreadsheet accounts for a yearly increase in rent, as well as increasing maintenance costs, utilities, insurance rates, and property taxes (since we don't live in California). I also have a field where the individual or family standard deduction can be entered in order to calculate the true financial benefit of the mortgage interest tax deduction.

So what am I leaving out? I'd like to make this financial comparison as complete as possible, and I'd appreciate any help you all have to offer. Thanks!

Update: Wow, thanks for all the feedback, everyone! I received more emails about this post than any post yet. It will take me a little while to update my spreadsheet to incorporate your ideas. I doubt I will be able to account for every suggestion, but I will do my best to make it as comprehensive as possible.

First off, I don't think the term "mortgage tsunami" is appropriate, since a tsunamis come with little warning and through no fault of those in their path. I'd call it more of a "mortgage harvest," considering that the mortgage banks and homebuyers are simply reaping what they have sown.

And why is it that they would like us to believe that the ongoing mortgage "mess" is not going to "break" the economy?

However, while stocks of subprime lenders have been pummeled, the industry's effect on the broader market is likely to be muted. "All told, subprime mortgages are worth about $640 billion, and that isn't chump change," says Bob Gay, economist and managing partner of Fenwick Advisers. "However, it's only 0.6 percent of annual gross domestic product. ... On the consumer side, it's not like every subprime mortgage is going to default and get repossessed."

Delightful. An argument that basically amounts to "because we say so."

Bizjournals compared housing costs and income levels in the 95 U.S. metros with populations above 500,000. The study used statistics from the 2005 American Community Survey, conducted by the U.S. Census Bureau. From our study, bizjournals identifies the 10 most affordable markets to own a home and the 10 costliest markets to own a home.

Keep in mind that many of the areas that were less affordable than us have seen slight price declines in 2006, meaning we've probably inched up the list a few spots since the data was gathered. Hooray for us!

I guess I don't understand how anyone would think that a $400,000 to $500,000 price tag on a town house is considered to be affordable housing. Not for folks who work for the city of Seattle making less than $35,000 a year. Not all of us are City Council members or managers.

Monday, March 12, 2007

As you know, I haven't said much on this blog about the ongoing collapse of lending as we've known it the last few years. This is primarily because the issue is being covered quite thoroughly at many of the other bubble blogs linked on the sidebar. However, a reader sent me a pdf report by Credit Suisse titled "Mortgage Liquidity du Jour: Underestimated No More" that contained the following chart:

As you can see, home buyers in Seattle have turned to interest-only and neg-am loans just about as frequently as most of the other "bubbly" cities.

As this easy money rapidly dries up, where does that leave the buyers? Well, I'll defer to the opinion of a "Mortgage Expert" on that one (comment #2):

It’s a real feeling of panic for buyers.

Uh-oh, it looks like we may not be as special as we thought. It would appear that all of Seattle's pretty scenery and "world class" amenities don't count for diddly when loans are no longer being handed out like bread crumbs at the duck pond.

P.S. (I have the report in pdf format, thanks to the reader that emailed it to me, but since I could not find a web link to it, and I don't know the copyright status of it, I have not posted the report online. If someone finds a link to the full report I will add it to the post.)

Some of my guesses for King County were fairly close, with the notable exception of Pending Sales (Res), which shot up to 2,375. That's +7.66% YOY, ending the 15-month streak of declining YOY sales.

Interestingly, despite the sudden surge in buyers last month, the median price was essentially flat compared to January, thus leading to the first single-digit YOY increase in median price (+9.41%) in over two years. This could be because although the number of sales is finally on the rise, the amount of inventory is still rising considerably quicker (+7.66% vs +22.50%).

Tuesday, March 06, 2007

Here's an article that appeared in the Everett Herald a few weeks ago about yet another misguided legislative attempt to solve the "housing crisis."

One of the bills Nathan Gorton is backing in the Legislature this year sounds like it makes too much sense to do anything but go down in flames.

What he'd like to see passed is a measure that would require cities to do what it takes to build enough homes each year to cover the number of new jobs they're expected to create. ...he'd like communities to provide homes for their own work force because it would stick fewer cars on the freeway for the morning commute.

I suppose if people were robots programmed to live only in the closest available place to where they work, legislation to that effect would indeed "make sense." However, as some of us are aware, people do not necessarily live in close proximity to their workplace, even if they can. Even the richest man on the planet, who can clearly choose to live anywhere he wants prefers to live with a 5-mile stretch of overcrowded SR-520 between his home and office.

Housing is important to Gorton. He's the new executive officer for the Snohomish County Camano Association of Realtors based in Everett.

Gorton noted Friday that three years ago, the median price for a home in Snohomish County was $220,000. Now it's $356,000.

"If you're a homeowner, it's a great thing," he said. "But we think we almost reaching a crisis point."

Oh we're reaching a crisis point all right, but not for the reason that home salesman Mr. Gorton is implying. Home prices have experienced such a steep ascent not because of a lack of legislation, but because of fly-by-night lending and pyramid scheme psychology.

Gorton said that from 1993 to 2000, King County added 237,000 jobs and 75,000 homes. Obviously, many of those workers had to look for a home somewhere else. There isn't a statistic handy, but conventional wisdom tells us that many of those workers bought a home in Snohomish County, where the prices are typically $50,000 less.

"That drives up housing prices outside King County and puts a lot of cars on the road," said Gorton, noting he's already hearing of Seattle workers who are buying homes in Whatcom County and making a very long commute each day.

Because there are simply no homes left from Seattle all the way to Bellingham. Right. Give me a break.

"It says if you're going to bring in a lot of jobs, let's do better with planning where you'll put those folks," Gorton said.

He thinks it will help keep home prices down and reduce freeway congestion, which he notes should make it a lot easier for businesses to recruit new employees. And you certainly don't need to be a business to want to reduce traffic and make it possible for people to buy homes.

Maybe it's just me, but Mr. Gorton's comments seem to have the same disingenuous feeling as the It's A Priority campaign—which incidentally is a project of the Washington Realtors, a group which Mr. Gorton is a member of. Hmm.